The real story of the muni bond market in the third quarter of 2017 was the impact of the three large named storms: Harvey, Irma, and Maria.
Harvey hit Texas on August 24th as a Category 4 hurricane. It was the first major hurricane to make landfall in the United States since Hurricane Wilma impacted Florida in 2005, and the first hurricane to make landfall in Texas since Hurricane Ike in 2008. Harvey caused massive flooding in the Houston area, with thousands of homes lost. Though damage estimates are still coming in, most are in the $100 billion-plus range, including large losses by uninsured homeowners. Part of the reaction to Harvey has been an upswing in oil prices as refinery operations in the Gulf area ground to a halt.
September 10th saw Hurricane Irma make landfall in the US Virgin Islands, causing catastrophic damage there and to the islands of St. Maarten and Barbuda. The storm then caused major damage in the Florida Keys and made landfall at Marco Island on the mainland of Florida. Irma’s predicted path had changed markedly in the days and even hours preceding landfall. Originally predicted to hit to the east coast of Florida, the 400-mile-wide storm veered toward the west coast of Florida at landfall but ultimately more or less plowed up through the middle of the state. Though there were widespread power disruptions and catastrophic damage in parts of the Keys, Florida was spared what could have been a much worse outcome if the direct hit had been on either coast. The total cost of Irma is estimated to be approximately $85 billion.
Bond market reactions to both Harvey and Irma were fairly small – perhaps a 10-basis-point uptick in yields, and that was mostly for the issues of local coastal jurisdictions as opposed to larger, more established issues.
On September 20th, Maria hit Puerto Rico head-on as a near-Category 5 hurricane. This was by far the worst of the three hurricanes, since it devastated the Commonwealth completely and produced an absolute human catastrophe. The insured damage estimates in Puerto Rico are $50–85 billion, and the uninsured losses are sure to be even more. Most of the island has been without power for a week and may be for months. Roads are impassable. Many residents are without shelter and food, and water supplies are meager at best. Landline phone service is nonexistent, and cell phone service is at about 20%. Rescue efforts are hampered by the damage to the airport, so that even people wanting to flee the devastation could not: The first few flights are only now making it in and out. Many trying to leave the island may face significant delays, perhaps for weeks. The rebuilding effort for Puerto Rico will be massive and will need federal help of a magnitude far greater than anything contemplated before the storm. We described our thoughts on a “Marshall Plan for the Caribbean” earlier this week. See http://cumber.com/a-marshall-plan-for-the-caribbean/. Congress cannot move fast enough here, and we would hope that the White House will take the lead.
Bond market reaction saw uninsured Puerto Rico bonds drop in price. Almost all have not been paying interest, so this is a price drop from the mid 50s to the low 50s. Insured Puerto Rico municipal bonds actually traded up in price (down in yield), with the market’s starting to discount federal help in rebuilding the infrastructure of the island.
Most times when disaster strikes we see immediate economic slowdowns in the affected areas and then a pickup in economic activity a few quarters later as the areas rebuild. The net effect on national GDP is fairly muted. But with the magnitude of these storms being so great and the storms coming within less than a month of each other, it remains to be seen what the overall economic effects will be. For example, between Harvey and Irma it is estimated that over one million cars will need to be replaced. That economic activity will be seen in the next few quarters as car manufacturers ramp up. The rebuilding that will go on – particularly in Puerto Rico – will have an impact on building supplies, construction equipment, skilled and unskilled labor, etc. Given the generally good state of the US economy and the relatively low unemployment rate, this activity could push up inflation from the low levels we have seen this year. The question will be whether the bond market views this economic pickup as temporary or more sustainable.
As for the rest of muni market, the quarter witnessed a drop of about 20 basis points in intermediate and longer tax-free yields from the end of the second quarter until Irma made landfall earlier this month. Since then yields have migrated upwards. This trend may be in anticipation of the higher expected level of economic activity that will follow these massive storms. My colleague Gabriel Hament and I wrote about possible bond market effects earlier this month. See http://cumber.com/us-hurricanes-and-the-bond-market/.
As we move into the fourth quarter, we will also be keeping an eye on the Federal Reserve, which is shaving its balance sheet by letting bonds mature and roll off without being replaced, even as it plans to continue incrementally raising short-term interest rates to match the pace of inflation.
Large infrastructure deals do not seem to have any problems being priced and bought by the market. (The Tappan Zee Bridge and La Guardia Airport in New York are just two examples.) Issuances by port authorities are also up substantially this year. So infrastructure is being financed even without any new mutuality from the white house.
As we reach the end of this quarter, our hearts and prayers are with all storm victims. And we hope that Congress does not drag its feet with aid, especially in the case of Puerto Rico. It is crucial that they move now.
John R. Mousseau, CFA
Executive Vice President & Director of Fixed Income
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